The Return of the Poison Pill

While financing for acquisitions has been tight this year, struggling companies still provide easy targets for firms that have weathered the credit...
Alan RappeportSeptember 10, 2008

Triggered by the current economic decline, smaller companies are displaying a renewed taste for deploying poison pills as a defense against takeovers, merger mavens think.

To be sure, the interest in poison pills has plummeted among American companies over the last-half-decade or so, with many allowing their shareholder-rights plans to expire. In the face of a sagging stock market and a struggling economy, however, fears about becoming acquisition targets have made some more open to popping the pill.

The plans are triggered when an investor acquires a certain large percentage of a company’s voting stock — usually 20 percent — without board approval. Once that happens, all other shareholders are allowed to buy additional voting stock at a discounted price, thus diluting the power of the acquirer. Although financing for acquisitions has been tight this year, struggling companies still provide easy targets for firms that have weathered the credit crunch.

That seems to have whetted new interest in poison pills. “I think that as the stock market drops and companies believe their stock is undervalued, they become more and more concerned about a takeover attempt at below-fair value,” says Gabor Garai, a partner in the private equity and venture capital practice at Foley and Lardner LLP. “So, it would be logical if poison pills would proliferate in a down market.”

Indeed, poison-pill adoption has risen so far this year. To date, 40 U.S. companies have adopted new poison pills for the first time, according to figures supplied by FactSet SharkRepellent, which tracks poison-pill trends. In all of 2007, 42 companies adopted poison pills.

Termination rates—which exclude the natural expiration of poison pills—are also leveling off this year. Fifteen companies have acted to terminate their poison pill plans, compared to 20 doing so in 2007, 30 terminations in 2006 and 41 in 2005.

“Companies that wanted to get rid of their poison pills have done so,” says John Laide, of FactSet SharkRepellent, noting that the sharp decline in poison pills has steadied itself.

Since August, at least three companies have adopted defensive measures to fend off potential suitors. Last week specialty drug-maker Alpharma Inc. — faced with an unsolicited $1.4 billion takeover bid from King Pharmaceuticals Inc. — adopted a shareholder-rights plan designed to thwart an offer that the target called “inadequate and not in the best interests of Alpharma shareholders.” The decision to implement the poison pill came in response to King’s Aug. 27 filing with the Federal Trade Commission that said that the company intends to acquire a majority of Alpharma’s common stock and seek clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, according to Alpharma. Its $33-a-share offer was at a 37-percent premium.

In mid-August, specialty retailer Charlotte Russe Holding adopted a stockholder-rights plan even though no specific takeover threat was looming. The firm’s shares were trading toward the bottom of their 52-week range, making the company somewhat vulnerable to an unsolicited takeover offer. The plan, according to the San Diego-based company, “should deter any attempt to acquire Charlotte Russe in a manner or on terms not approved by Charlotte Russe’s board of directors and, in some cases, the stockholders.”

And early last month Hovnanian Enterprises, the big real estate developer, announced it was adopting a shareholder-rights plan to preserve tax benefits related to its net operating losses. In that case, the move was intended to ensure that recent losses could still be used to offset future gains and ultimately lower future tax bills.

Up until recently, however, the views of activist investors and other critics, who argue that shareholder-rights plans entrench management and prevent companies from maximizing shareholder value, have held sway. In 2002, 60 percent of public companies in the United States had poison pills in place. That number dropped to 28 percent by the end of 2007.

Nevertheless, the decline of interest in the anti-takeover tool may have flattened. Although so far this year the number stands at 24 percent, according to FactSet SharkRepellent, the small decline from the previous year is largely due to expiring plans. Most of the new adopters are vulnerable microcap companies that do not list on the S&P 1500, according to Laide.

“I would see a reversal in the trend,” says Robert Schreck, a partner in the mergers and acquisitions group at the law firm McDermott Will & Emery. “I still think that the poison pill is the best defense available.”

But poison pills are still considered a “nuclear” option, says Schreck. Critics contend that such plans, initially approved for use in 1985, actually devalue companies. “A poison pill creates an unmitigated ban on [a single shareholder] acquiring more than a certain percentage of stock,” wrote Carl Icahn, the famous corporate raider and activist investor, on his blog in June. “A purchaser who desires to buy and the seller who wishes to sell are simply out of luck. Board members should not be allowed to hide behind a poison pill indefinitely.”